Racing fans betting on California Chrome were disappointed recently when he failed to win the Triple Crown, coming in fourth at the Belmont Stakes. The fact that he was an overwhelming favorite didn’t make the race’s outcome a forgone conclusion. It only made the risk-return ratio less attractive since the pay out from a heavy favorite is much less than from a horse with lower odds of winning. Oh, if picking winners were only so easy!
We commonly use sports analogies when discussing investing. However, there is a world of difference between investing and speculating. When betting on a horse, if you don’t get the desired outcome, you will suffer a total and permanent loss of your wager. Conversely, a prudently diversified investment portfolio, while subject to the risk of periodic, temporary declines in value, is not subject to the risk of permanent and total loss inherent in speculative activities.
Wealthview Capital manages portfolios consistent with the three major tenants of Modern Portfolio Theory (MPT) - optimal asset allocation, proper diversification and periodic rebalancing. Many investors cannot accept that successful investing can be so simple and therefore continue an expensive, risky and futile search for that stock, mutual fund, asset manager or horse that can deliver superior returns. There is no substitute for a diversified, tax-efficient, low-cost and periodically rebalanced investment strategy.
The second quarter of 2014 validated this theory better than any horse racing analogy. Last year, emerging international markets suffered the unpleasant distinction of being the worst performing major equity sector as slowing economies and geopolitical tensions sent investors fleeing this higher risk group of 21 developing countries. If emerging markets were a horse, it finished dead last and U.S. small-cap stocks won going away. As fate (or MPT) would have it, emerging markets completed 2Q-14 in first place and last year’s California Chrome (U.S. small-caps) came up limping.
The point here is that what goes around usually comes around. An intelligent investment strategy can help investors achieve their goals without unnecessary risk, added costs and inefficient taxation. No one, including Wealthview Capital, can predict next year’s winners consistently. We’ll leave that folly for others and wish them the best as they look for the next horse on which to place their bets.
Market Summary
The stock market produced handsome returns in 2Q-14 with the aforementioned emerging markets index leading the pack, up 6.60%. U.S. large and mid-cap companies and developed international markets followed in order, as small-cap U.S. companies brought up the rear, gaining 2.07%. During the year’s first half, U.S. mid-cap and international emerging markets ran a dead-heat up 7.50% and 7.40% respectively. Last year’s winner, small-cap stocks finished the year’s first half in last place, up 3.22%.
Bonds posted decent returns with longer maturities outperforming shorter issues. Our bond benchmark, Barclay’s 1-5 Year Corporate Bond Index, gained 0.97% for the quarter and 1.80% for the year’s first half. Interest rates fell as investors became less concerned about the impact of reduced Fed quantitative easing and also due to a flight to quality, resulting from mounting worldwide tensions, especially in the Ukraine and Iraq. Precious metals investors saw gold gain 1.80% and silver up 4.51% for the quarter. Year to date, gold and silver posted gains of 9.45% and 7.03%, respectively. Unfortunately, three-year returns for this group remain negative.
As of this writing, the Dow Jones Industrial Average surpassed 17,000 for the first time in history. That is a 10-year gain of 65% (excluding dividends) which is below the long-term average of 103%. Additionally, the stock market recently surpassed 1,000 days without a 10% correction. While unusual, it doesn’t mean a correction is imminent. Part of the reason for the extended rally is rising investor confidence from extremely depressed levels, increased productivity enhancing corporate profitability and few attractive investment alternatives. I know few people who can get excited about investing in a 10-year U.S. Treasury note yielding 2.63%.
Our economy is continuing to accelerate as evidenced by the May jobs report showing nonfarm payroll gains of 288,000. Also, the combined gains from the prior two months were revised up 29,000 and our unemployment rate is now down to 6.1%. The slack in the labor market is definitely diminishing which could lead the Federal Reserve to start raising rates earlier than expected. 1Q-GDP fell at an annualized rate of -2.9% but that was mostly weather related and predictions are that 2Q-GDP numbers will come in around 2.5% - 3% annualized. For the first time since 1993, stock, bond and commodities all posted gains for the first half of the year. This meant that almost all investors made money during the year’s first half. You simply must be invested to move your horse down the track. Remaining in the starting gate (cash) is not going to get the job done.
Understanding Your Performance – Potato or Potata?
Beginning this year you will see two different performance numbers for the same time periods – Time Weighted Return (TWR) and Internal Rate of Return (IRR). Why use two? Because they measure different things. TWR measures how your underlying investments performed and is not influenced by cash flows. IRR (also called dollar-weighted return) measures the return on each dollar invested during the period and is influenced by cash flows into and out of your account. Another way to say it is that TWR measures how your asset manager is doing but IRR measures how you are actually doing. How can these differ and why does it matter?
The timing of cash flows into or out of your account can greatly impact your results. For example, if you made a large deposit right before a big move in the market (up or down) it would exaggerate your results, positively or negatively. It matters because your portfolio manager has little control over when you contribute to or withdraw money from your account. Without both numbers someone might unfairly assign credit or blame to those making the investment decisions when it was actually the investor’s action that caused the gain or loss. If there are no cash flows other than the initial deposit, TWR & IRR will be identical.
Part of a fiduciary standard of care is transparency and avoiding conflicts of interest. Many investors are unaware that there is more than one way to report performance and simply accept a number provided by their advisor, if they are provided performance at all. Since this can be a conflict of interest, Wealthview Capital does not calculate your performance but instead, outsources this important responsibility to an independent portfolio accounting service. Orion Advisor Services of Omaha, NE, creates your report in compliance with GIPS (Global Investment Performance Standards). Presenting both of these numbers in one report has been a technical challenge and we thank Orion for their efforts. We hope you will appreciate this enhanced level of transparency.
Summer Fun
With summer in full swing many investors are now preoccupied with family outings and making memories. However, don’t neglect the little things that can make big differences. If there is anything we need to know that might influence our management of your assets, please bring it to our attention.